As rising interest rates hammer financial markets, stocks offering consistent dividend growth are outperforming the growth stocks that have dominated the last decade.
The S&P 500 Dividend Aristocrats index — which tracks companies that have increased the annual dividend they pay shareholders for at least the last 25 years — is down 14.4% since the start of 2022, while the broader S&P 500 index is down 20.5%. Growth stocks, which offer profits in the future, have suffered worse, with the long-dominant S&P 500 Growth index down 26.9% in 2022 as of Sept. 22.
Rising interest rates lower future earnings, reducing the appeal of growth stocks. Dividend strategies follow companies that already generate free cash flow and tend to perform well even in an environment of slowing growth or recessions. Economists at S&P Global Market Intelligence forecast the U.S. economy to grow by 1.7% in 2022 and then 1% in 2023, while dividend payouts are set to rise over the same time.
"Dividends are an important element of long-term equity returns, forming about one-third of returns since 1940. This becomes even more important when capital returns are more muted," said Mark Peden, manager of the Aegon Global Equity Income Fund. Dividends will form a bigger proportion of total returns for investors this year than at any time in the past decade, Peden said.
Market Intelligence economists forecast total dividends paid by S&P 500 companies will grow by 8.2% to $565.1 billion in 2022 and a further 6.8% to $603.6 billion in 2023.
Energy companies listed on the index have increased their special payments to $18.3 billion so far this year, compared to just $4.4 billion for the whole of 2021. Utilities, another popular value play during market volatility, are expected to increase their dividend payouts by 6%.
"While markets have sold off with few places to hide, investors may continue to find comfort in dividend-paying securities," said Ian VanderHorn, senior associate at Market Intelligence.
Swiss bank UBS is also advising investors to move into cash or more defensive stocks such as healthcare and consumer staples that tend to pay dividends.
"U.S. growth is likely to slow below trend, and the Eurozone is likely to experience a recession in the quarters ahead, so we think investors should consider adding exposure to more defensive parts of the equity market, which are typically more resilient as growth slows or stalls temporarily," UBS strategists wrote in a Sept. 14 research note.
The level of dividends in each industry is expected to follow macroeconomic trends. Banking and energy, for example, will benefit from rising interest rates and higher energy prices, respectively, VanderHorn with Market Intelligence said.
"Other rotational trends will also be present in dividend payments as consumer demand shifts from products to travel, with the travel and leisure sector expected to grow substantially," VanderHorn said.
Hunt for returns
The relative performance of dividend stocks is part of the general shift away from growth stocks to value. Value stocks are defined as being underpriced on the basis of certain fundamentals like earnings or dividend yield.
Dividend-offering stocks fell out of fashion in recent decades, as cheap money facilitated by low interest rates and trillions of dollars of asset purchases by the Federal Reserve fueled an explosion in growth-centered tech stocks offering the promise of greater profits in the future.
The era of low-interest rates now appears to be over as inflation proves more persistent than many thought. The worse-than-expected consumer price inflation reading for August dashed investor hopes that the Federal Reserve will slow its pace of monetary tightening. The S&P 500 and more tech-heavy Nasdaq had their worst days since June 2020 as a result, falling by 4.3% and 5.2%, respectively, as investors priced in a third 75-basis-point hike in rates by the Fed in 2022.
"[S&P 500 Dividend Aristocrats] that might offer a proxy for those whose business models and operations may be better positioned to pass through higher inflation, or otherwise limit any margin compression from higher inflation and higher interest rates," said Tim Edwards, managing director of index investment strategy at S&P Dow Jones Indices.
Traditional sectors like energy, materials and utilities reliably pay dividends despite often not having the highest valuations. High-valued growth stocks in the information technology, consumer discretionary and communication services sectors are much less likely to pay dividends.
The good news for investors is that dividends continue to grow reliably. The indicated annual dividend rate of S&P 500 companies — calculated from the monthly dividend — topped $550 billion for the first time in late July. In the last 25 years, the growth in value of dividend payments has only been interrupted briefly, first by the 2008 financial crisis and then by COVID-19.
Companies like The Coca-Cola Co. and The Procter & Gamble Co. are among eight companies that have delivered dividend increases for at least 59 years, according to S&P Dow Jones Indices data. Microsoft Corp. has the highest annual dividend spend at $18.5 billion, ahead of fellow tech titan Apple Inc. at $14.9 billion and energy giant Exxon Mobil Corp. at $14.8 billion.
"Dividends have a good track record of keeping pace with inflation. In the U.S., companies that pay dividends tend to outperform those that don’t in times of high inflation and rising rates," Peden said. "They also tend to be more defensive options, meaning they tend to fall less than the market in down periods. This is important in the current, volatile conditions."
S&P Global Dow Jones Indices and S&P Global Market Intelligence are owned by S&P Global Inc.